Demand Forecasting

Aim/Purpose of the forecasting

1. Purposes of short-term forecasting Appropriate production scheduling. Reducing costs of purchasing raw materials. Determining appropriate price policy Setting sales targets and establishing

controls and incentives. Evolving a suitable advertising and

promotional campaign. Forecasting short term financial

requirements

Purposes of long-term forecasting Planning of a new unit or expansion of

an existing unit. Planning long term financial

requirements. Planning man-power requirements.

Demand forecastingIt involves determining the expected

level of demand during the period under consideration

 Factors involved in Demand Forecasting

Undertaken at three levels:Macro-level Industry level eg., trade associations Firm level

Criteria of a good forecasting method

Accuracy – measured by (a) degree of deviations between forecasts and actuals, and (b) the extent of success in forecasting directional changes.

Simplicity. Economy. Availability. Maintenance of timeliness.

Length of forecasts 

• Short-term forecasts – upto 12 months, eg., sales quotas, inventory control, production schedules, planning cash flows, budgeting.

• Medium-term – 1-2 years, eg., rate of maintenance, schedule of operations, budgetary control over expenses.

• Long-term – 3-10 years, eg., capital expenditures, personnel requirements, financial requirements, raw material requirements.

Forecasting Steps1. Identification of objective: what does one want to get from the

forecast

2. Determining the nature of goods under consideration: Different

categories of goods like consumer goods, durables and non-

durables, have their own characteristics and distinct demand

patterns

3. Selecting a proper method of forecasting: The selection of

appropriate method is based on type of data available, period for

which forecast is to be made etc.

4. Interpretation of results: A good forecast depends on the efficiency

in the interpretation of its results.

Methods of demand forecasting

No forecast can be expected to be cent percent correct

There are several methods of forecasting basically for three reasons:

1. No method is perfect and no method is useless

2. No method is best under all circumstances, and

3. The best method may not be available in particular situation due to constraint from data , time and money.

Forecasting techniques

Qualitative Techniques

Quantitative Techniques

Expert opinion

Method

Survey Methods

Complete Enumeration

Survey Method

Sample Survey Method

Sales force Opinion survey

Method

End Use

Survey

Method

Trend

Projection Method

Barometric Technique

Econometric Techniques

Regression Method

Simultaneous Equation Method

Qualitative forecasting is based on opinion & intuition.

Used when data are limited, unavailable, or not currently relevant

Quantitative forecasting uses mathematical models & historical data to make forecasts. Time series models are the most frequently used

among all the quantitative forecasting models.

Expert Opinion MethodTake the views of experts regarding the

demand in the futureExperts are informed persons who know the

product very well as they have dealing with it and related products for a long time

If the forecasting is based on the opinion of several experts, then it is known as panel consensus (or agreement)

One disadvantage: Powerful individual could have influenced the consensus

Delphi Method: This is the specialized form of panel opinion.

This method seeks the opinion of a group of experts through mail about the expected level of demand

The responses so received are analyzed by an independent body

Advantages

(a)It is simple to conduct

(b)Can be used where quantitative data is not possible

(c) The forecast is reliable as it is based on the opinion of people who know the product very well

(d)It is inexpensive

(e) It takes little time

Disadvantages

(a)This is not a scientific analysis, it is based on mere guess of one or more persons

(b)The experts may be biased

(c) Forecast could be unfavourably influenced by persons with vested interests

Complete Enumeration Survey Method

Complete survey of all the consumers for the commodity

Interviews or questionnaires are used to ask consumers about the quantity of the commodity they would like to buy

Data collected and added up then arrive at the total expected demand for that product

Advantages(a)Quite accurate as it surveys all the

consumers of a product

(b)It is simple to use

(c) It is not affected by personal bias

(d)It is based on collected data

Disadvantages

(a)It is costly

(b)It is time consuming

(c) It is difficult and practically impossible to survey all the consumers

(d)Useful only for products with limited consumers

Sample Survey Method

Instead of surveying all the consumers of a commodity, only a few consumers are selected and their views on the probable demand are collected

Population

Sample

Advantages

(a)It is simple and does not cost much

(b)Since only a few consumers are to be approached, the methods works quickly

(c) The risk of handling a large number of data is reduced

(d)It gives excellent results, if used carefully

Disadvantages

(a)The conclusions are based on the view of only a few consumers and not all of them

(b)The sample may not be a true representation of the entire population

Advantages:(a)Perhaps the simplest of the forecasting methods

(b)It is less costly

(c)Collecting data from its own employees is easier for a firm than to do it from external parties

Disadvantages:

(a)Sales force may give biased views as the projected demand affects their future job prospects

(b)Sales force may not be expertise to predict the future demand.

Sales Force Opinion Method

Similar to the expert opinion methodInstead of external experts, employees of the

company who are a part of the sales and marketing teams are asked to predict future levels of demand

The sales force, who has been selling the product over a period of time, is considered to know the product and demand pattern very well

End Use Survey Method A commodity that is used for the production of

some other finally consumable good is known as an intermediary good

This method focuses on forecasting the demand for intermediary goods

Such goods can be exported or imported besides being used for domestic production of other goods

For example, milk is a commodity which can be used as an intermediary good for the production of ice cream, paneer and other dairy products.

= Final consumption demand for milk

=Export demand for milk

=Import of milk

=Per unit milk requirement of the ice cream industry

=Output of the ice cream industry

notations are similar to for paneer

mcD

nnppiimmemcm oxoxoxIDDD .........

meD

mI

ix

iopp ox & ii ox &

Advantages:

(a)The method yields accurate predictions

(b)It provides sector wise demand forecast for different industries

Disadvantages:

(a)It requires complex and diverse calculation

(b)It is costlier as compared to other survey methods and is more time consuming

(c)Industry data may not be readily available

Quantitative Methods

Trend Projection Method

It is based on the assumption that the future is an extension of the past. Historical data is used to predict future demand.

The trend could be linear or curvilinearThere are two trend methods:Graphical methodAlgebraic method

Graphical method: The past data will be plotted on a graph

The identified trend will be extended further in the same pattern to ascertain the demand in the forecast period

In the figure trend 1 is linear, trend 2 is non-linear

Dem

and

Trend 2

Algebraic methodThis is also known as the least square methodThe demand and period data are fitted into a

mathematical equationSome of the most common trend equations

are:

1.Linear trend : Y=a + bX

2.Quadratic trend : Y=a + bX + cX2

3. Cubic trend : Y= a + bX + cX2 +dX3

The linear trend is the most widely used mode of time series analysis

Y = a + bX

Where, Y= Demand

X= Time period (number of years)

a and b are constants

a = Intercept

b = Slope of the line

The calculation of Y for any value of X requires the values of a and b. For this two normal equations are to be solved. These are:

∑Y= na + b∑X

∑XY = a ∑X + b ∑X2

Advantages:

1.It is very simple method

2.The method provides reasonably accurate forecasts

3.It is quick and inexpensiveDisadvantages:1. Can be used only if past data is available

2. It is not necessary that past trends may continue to hold good in the future as well

3. Does not consider any possible causal relationships that underlie the forecasted variable

Barometric Technique The Bhuj earthquake in January 2001, lead to a massive destruction of property & buildings in Gujrat.

This necessitated construction of buildings to rehabilitate the people of affected areas.

The construction was followed by a spurt in the demand for cement, fans, tube lights, etc.

Thus, construction of buildings leads to the demand for cement.

Here, construction of buildings is the leading indicator or the barometer

Erratic cyclical patterns in time series.

Movements of different economic variables

Correlation between two time series can of three types:

1. Second series moves ahead of the first series then second series is known as the leading series while the first series is

called lagging series.2. First series moves ahead of the second series then

first series is known as the leading series while the second series is called lagging series

3. If both of them move along with each other then the series are called coincident series

It uses the lead and lag relationship between economic variables for predicting the directional changes in the concerned variables.

This technique requires establishing the lead-lag relationship between the two series

Advantages:

1.It is simple method

2.It predicts directional changes quite accurately

Disadvantages:

1.It does not predict the magnitude of changes very well

2.The method can be used for short-term forecast only

Econometric TechniquesBoth economic theory & mathematical tools are

applied in this method

1. Regression Method:

Forecasting problems can often be analyzed with single equation econometric models. This is called the regression method. The relevant equation is:

Where, a, b, c, d and e are constants

=Demand for X, I= Consumer’s income

=Price of X, A= Advertisement outlay

= Price of its substitute product Y

yxx ePdAcIbPaD

xD

xP

yP

Advantages:1. As the method is based on causal relationships, it

produces reliable & accurate results

2. This method not only forecasts the direction but also the magnitude of the change

3. The method is quite consistent

Disadvantages:1. The method uses complex calculations

2. It is costly & time consuming

Simultaneous equation method

When the inter-relationship between the economic variables becomes complex, the use of single equation regression method becomes difficult

In such cases, forecasting of demand is done using multiple simultaneous equations

A detailed discussion of this method is not included in our syllabus